USC Gould School of Law

1. USC Gould School of Law January 15, 2010 Tax Expenditure Framework Legislation Edward D. Kleinbard Professor of Law ekleinbard@law.usc.edu

2. Tax Expenditures • Different definitions, but for purposes of this paper Tax Expenditures = “Tax Subsidies ” as used in JCT (2008) • Tax Subsidy = a specific tax provision that is deliberately inconsistent with an identifiable general rule of present tax law and that collects less revenue than does the general rule • Tax subsidies constitute synthetic spending: they function like explicit government spending programs • Many tax subsidies are analogous to “entitlement” programs –they are open-ended and available to any eligible person (e.g. mortgage deduction) • Others function like appropriations, right down to a fixed dollar allocation and an application process (low-income housing credit)

3. Budget Framework Legislation • Framework legislation: a statute that adopts internal rules of procedure by which a legislature goes about developing substantive legislation in a specific area • Framework legislation is a “precommitment” device: legislators agree to a process before they necessarily know the substantive issue to which the process will apply • The budget process is best-known example • Framework legislation requires some preconditions • A sense of urgency, to justify constraining process • A clearly defined scope of application so that framework is triggered appropriately • Perceived neutrality in information and application

4. Tax Expenditure Framework Legislation • Budget framework legislation today privileges tax expenditures by ignoring them in the process • Result: Tax expenditures are now the preferred vehicle for delivering new spending programs • Government is larger, and distortive effects on economy greater, than generally understood – to the tune of $1 trillion+/year • By relying on the work of JCT (2008) it is possible to extend budget framework to encompass tax expenditures, and existing addiction to tax expenditures should create necessary urgency

5. Accounting for Tax Expenditures • How do tax expenditures escape budget framework? • By hiding in plain sight! • Accounted for as reductions in government revenues (inflows), while they function as equivalents to government spending (outlays) • Example: Cash for Clunkers • As a spending program, accounted for as an increase in government spending • But had it been structured as a Tax Credit for Clunkers, would be accounted for as simply lower tax revenues, although having the same economic cost to government and (in general) same allocative effects as spending

6. Addiction to Tax Expenditures • FY 2008: 247 identified tax expenditures, sum of which = $1.2 trillion • $118 billion business, $1.1 trillion individuals • Exceeds total individual income tax collections • Exceeds total explicit discretionary spending • Twice as large as nondefense discretionary spending • Rapidly growing (again) • 1974: 5.7% of GDP • 1985: 8.7% • 1989: 5.4% • 2008: 8.6% • A symptom of institutional weakness in the design of current budget framework legislation

7. Current Tax Expenditure Framework Rules - I • Tax Expenditure Budget • Required by Budget Act (1974); prepared by JCT Staff (as subcontractor to CBO) • Originally seen by SBC as tool to compel tax reforms, but rebuffed by SFC • Today, serves simply as a hortatory memorandum account, or alternatively a fishing ground for revenue payfors • Limited Tax Benefits • Technically rules rather than framework legislation • But now work by appointing foxes to guard henhouses • W&M Chairman in 2007, and SFC Chairman in 2008, each adopted idiosyncratic reading to declare that a bill in which he had an interest was not a tax earmark

8. Current Tax Expenditure Framework Rules - II • PAYGO • Has been framework legislation (with sequestration remedy) in the past, but today are House and Senate Rules • Effectively requires tax (revenue) raiser to offset new tax expenditure • Calculated by comparing projected 10-year costs to projected 10-year revenues • PAYGO does constrain tax expenditure growth • But is a victim of simplistic accounting • Present value calculations ignored • Temporary provisions can be matched against permanent ones • No “do-overs” for mis-estimation • And of simply being ignored when inconvenient

9. PAYGO Is Ineffective and Perverse • Ineffective • Even if perfectly accounted for, PAYGO does not address privileging of tax expenditures in budget process • Perverse • Procrustean trimming of policies to fit payfors • Reduces tax and spending salience: new taxes and spending programs are presented as budget nothings, because they net to zero, although government in fact has grown • A classic example of fiscal illusion: tax and spend policies are understood as “targeted tax relief” • Revenue raisers are captured for use as expenditure payfors, rather than general rate reduction • Empowers the taxwriting committees as a Congress within the Congress

10. Folding Tax Expenditures into the System • The numbers suggest that the requisite sense of urgency should be present • Tax expenditure analysis formerly failed the critical condition of generally-perceived neutrality, but JCT (2008) addressed this problem, by separating out policy questions from simple tax subsidies • Proposal: • Define tax expenditures as per JCT (2008) definition of tax subsidies • Require CBO to identify new tax subsidies in revenue legislation (like unfunded mandates)

11. Classifying Tax Subsidies for Budget Purposes • “Fixed-dollar allocation tax subsidies” • Ceiling imposed and typically administered like grants • Example: Low income housing tax credit • Function interchangeably with appropriations • Temporary uncapped tax subsidies” • Open-ended (like entitlement) but limited in time • Example: First-time homebuyer’s tax credit • Intermediate case, but arguably closer to appropriations • “Permanent uncapped tax subsidies” • Open-ended (like entitlements) and indefinite in time • Example: Employer-sponsored health insurance premium exclusion • Raises all the same budgetary control issues as do classic entitlements programs, like Medicare

12. Rules of Application • Proposals in General: • Authorizing committee must shape and control, and refer to taxwriting committee only for implementation • Tax subsidies are on budget in all cases and generally reported on an “expenditure equivalent” basis • Where tax subsidy is an appropriations-equivalent, budget process and consequences are same as appropriations, • Where tax subsidy is entitlements-equivalent, tax subsidy follows entitlements framework pipeline • Entitlements-equivalent tax subsidies must satisfy PAYGO • But PAYGO accounting rules reformed to eliminate budget window gaming, absence of present value concepts, etc.

13. Goals of Proposals • Proposals are salutary in several dimensions: • Ends race between authorizing and taxwriting committees to capture new programs • Empowers authorizing committees to enhance their subject-matter expertise and to coordinate different programs • Counterbalances trend to emasculation of authorizing committees • Limits use of Tax Code to cases where a strong case can be made that it is the superior benefit delivery system • Disenfranchises the Congress within a Congress – new tax revenues are available to all committees to squabble over • Focuses role of taxwriting committees on tax matters • PAYGO remains for entitlements-equivalent cases • But it no longer encourages fiscal illusion

14. Framework Legislation and Tax Reform • Framework processes work because they are couched as procedural rules and negotiated in advance of (and in isolation from) substantive debates • Framework rules generally look forward not backwards • Tax expenditure framework legislation thus is an implausible device for “cleaning up the Tax Code” • But framework rules might preserve a reform deal • Establish target ceilings on tax subsidies as a percentage of projected GDP • By relying on projections, subsequent economic events cannot by themselves trigger an enforcement mechanism • Enforce not by sequestering disbursements, but by imposing automatic tax surcharge